Yellen Likely to Be Grilled on Fed’s Regulatory Role

Janet Yellen is known more for her expertise on monetary policy than bank rules, but she is likely to get as many questions about the Federal Reserve’s regulatory role on Thursday during her hearing to be its next chief.

Associated Press

The Federal Reserve building in Washington.

Several members of the Senate Banking Committee, which is holding the hearing, are concerned that regulators haven’t done enough to rein in the nation’s largest financial firms in the years since the 2008 crisis. The issue animates Democrats on the committee as well as Republicans.

Some lawmakers plan to grill Ms. Yellen, currently the Fed’s vice chairwoman, on how she would ensure banks aren’t able to grow so big that the government would have to rescue them in a crisis so their failure wouldn’t destabilize the rest of the financial system — a condition colloquially called “too big to fail.”

Sen. David Vitter (R. La.) and Sen. Sherrod Brown (D., Ohio), both members of the banking panel, are pushing legislation to increase the capital cushions banks must hold against losses. When Mr. Vitter met with Ms. Yellen, he pressed her on what further regulatory steps she could support to end “too big to fail” and plans to revisit the issue in her confirmation hearing.

“She’s open to where I want to go on greater capital requirements on banks,” Mr. Vitter said in an interview after the meeting. The lawmaker said he asked her to be “very specific” on the issue of bank capital requirements when she appears before the panel.

“That would help me get to a positive vote,” he said.

A number of other senators on the banking panel have signaled they will press Ms. Yellen on various regulatory issues. Sen. Joe Manchin (D., W.Va.) said he raised his concerns, in a private meeting with Ms. Yellen that big banks could balloon into megabanks. Ms. Yellen didn’t defensively back current policy, he said in an interview Tuesday. “She was open to the options” for strengthening the financial system, Mr. Manchin said.

The issue of too big to fail stems from experiences during the crisis when regulators faced the unpalatable decision of either committing billions in taxpayer dollars to prevent a failure of a megafirm, as in the case of American International Group, or letting its messy collapse disrupt financial markets, as happened with Lehman Brothers Holdings Inc.

The 2010 Dodd-Frank financial law contained a number of provisions designed to prevent firms from becoming “too big to fail.” These include new powers allowing regulators to seize and dismantle tottering financial firms outside of the normal bankruptcy process. The law also directed the Fed to devise tougher capital rules and other standards for the nation’s largest financial firms.

Some lawmakers believe regulators need to go further. These include Elizabeth Warren (D. Mass), another banking panel member. “We should not accept a financial system that allows the biggest banks to emerge from a crisis in record-setting shape while working Americans continue to struggle,” she said in a speech Tuesday. “And we should not accept a regulatory system that is so besieged by lobbyists for the big banks that it takes years to deliver rules and then the rules that are delivered are often watered-down and ineffective.”

Oregon Democrat Jeff Merkley said his questions on Thursday would also focus on how the Fed will implement the Volcker rule, a controversial Dodd-Frank provision which he and Sen. Carl Levin (D., Mich.) helped develop to prevent banks from trading with their own money and other types of risk-taking.

“I hope the Fed will play a strong role in creating a loophole-free Volcker firewall,” Mr. Merkley said, noting that the rule’s intent was to ensure that firms that can tap the Fed’s discount window, which provides short-term loans, shouldn’t be able to wager with those taxpayer-backed funds.

Ms. Yellen hasn’t said much in the past few years about her regulatory views. Her most recent comments came in June when she echoed the thinking of Fed governor Daniel Tarullo, the Fed’s point man on regulation. She said she doesn’t favor breaking up the banks by re-imposing the Depression-era Glass Steagall law that separated commercial and investment banks. But she did say the Fed might need to require the nation’s largest, most complex banks to carry fatter capital cushions against losses than required by new rules set out by international regulators, a prospect hotly contested by big U.S. banks.

Ms. Yellen could also get questions about her regulatory record as president of the San Francisco Fed from 2004 until 2010, the chief regulator for scores of banks — a number of which failed during the crisis. (For Ms. Yellen’s take on her record see this post.)

Sen. Richard Shelby (R., Ala.), a member of the banking committee, said he voted against confirming Ms. Yellen as Fed vice chairwoman in 2010 due partly to concerns about her role overlooking the makings of the financial crisis while president of the San Francisco Fed.

“I thought they were asleep on the subprime crisis, the housing crisis there,” he said in an interview late Tuesday. “Right now I think that the role of the regulator is very important in what the Fed does and doesn’t do.”

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